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ESG activism tough but doable in emerging markets

Assessing environmental, social and governance risks (ESG) within companies based in emerging markets is particularly challenging, but it’s also key to sound long-term investing.

That is the firm view of JP Morgan Asset Management head of emerging markets Asia-Pacific equities team sector research Mark Ferguson.

Good governance has long been a natural part of JP Morgan Asset Management’s criteria for long-term investment choices in emerging markets, Ferguson said. The firm’s 35-member emerging markets equities team, based across seven locations, has strong engagement with the management of the roughly 980 stocks in the portfolio, to promote good ESG practices.

“We do think, particularly with emerging markets, there are no easy short cuts,” Ferguson said. “To make the right judgement, you need to understand these companies properly and to do that you need to be on the ground.”

Ferguson said engaging with company management via more than 5000 meetings each year allows JP Morgan analysts to raise ESG concerns and steer companies in the right direction, with varying degrees of success.

One success story was the case of a South African drug store company, in which JP Morgan owned a 5 per cent stake, that has scrapped its plans for a preference share scheme boosting management incentives, following the recommendation of the fund manager’s analysts.

Another case study Ferguson shared was that of a Russian oil company that, despite low expectations, improved its environmental footprint in response to analysts’ advice.

This “improved our opinion of the company and helped us understand management better”, Ferguson said; however, he said things were progressing much more slowly when it came to improving corporate governance standards in South Korea and China.

Consumer companies measure up

Using a 98-question risk-profile assessment, with a heavy tilt towards governance, JP Morgan classifies its emerging market equity holdings in terms of economic, duration or sustainability and governance grounds over a five-year time frame.

What the firm found was that businesses destroying the environment or abusing the community in which they operated were “simply not thinking about their long-term future”, Ferguson said.

While only 50 or 60 stocks among the 980 in the portfolio had similar governance standards to peers in advanced economies, JP Morgan was “prepared to accept slightly lower standards, as long as operational factors compensated,” Ferguson said.

“Taking everything into account, the more a consumer business fulfils our criteria, the more it tends to be a very good business and most consumer companies making good returns are well managed.”

His team steers away from capital- and resource-intensive companies and state-owned enterprises, in favour of more asset-light, mostly private-sector firms, Ferguson said. This meant the portfolio had significant exposure to companies with large numbers of customers in consumer and financial sectors, and the internet services industry; however, state-owned enterprises comprise 30 per cent of the emerging market index, so some exposure to this sector, particularly in China, was necessary.

JP Morgan clients, including local superannuation funds, generally expect a high level of ESG risk management but the emphasis varies depending on geography, Ferguson said. He explained that pension funds from Nordic countries and the Netherlands have been at the forefront of ESG issues, while those on the US West Coast are more concerned about energy and environmental sustainability, and southern US clients tend to avoid “sin stocks” such as those that profit from gambling and alcohol.

Ferguson made his comments in a keynote address to the 2017 Conexus Financial Equities Summit.

Session chair Lucy Thomas, who is global head of sustainability at asset consulting firm Willis Towers Watson, noted developed market governments are driving up ESG standards in emerging markets. She cited how anti-slavery legislation in Britain has put pressure on consumer-related companies’ supply chains globally.

Conexus Financial is the publisher of Investment Magazine, top1000funds, and Professional Planner. For details on upcoming events visit conexusfinancial.com.au/events.

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